The ECB stress and capital adequacy tests are already forgotten

Outlook:

The calendar today includes durable goods, Case Shiller home prices, and con-sumer confidence. Durables are the main event, since we use non-defense capital spending ex-aircraft as a proxy for business sentiment and the basis of future capacity.

The comparison between the US and Europe, the divergence story, continues to be the main focus. The ECB stress and capital adequacy tests are already forgotten, although some post-mortems have a com-ment or two of interest. One (from UBS in the NYT) is that “An improving banking sector is perhaps a necessary but not a sufficient condition for a more meaningful recovery in credit growth — and in the overall health of the eurozone.” Now that the ECB says you can make loans doesn’t mean you will. Pri-vate sector loans fell 1.2% annualized in Sept, according to the ECB yesterday—it’s a long row to hoe to get back to anything resembling real growth. Weinberg at High Frequency Economics estimates that half of the 130 banks have only “thin” capital buffers and will be wary.

Let’s face it, the big event of the week is the FOMC starting today and ending tomorrow with the state-ment (no press conference, no data revisions). The consensus has it that the end of QE will be con-firmed, having been announced in June and challenged only once (Bullard suggesting it might be post-poned but nobody picking up the banner). As before, analysts are obsessing about the inclusion of the phrase “considerable period,” but since it’s so vague and especially since we don’t know the starting point—is it tomorrow?—we say neurotic ramblings about “considerable period” are a waste of time. One of the Feds said the First Rate Hike won’t come before summer, so now we need to define when summer begins—June 30, maybe. If we don’t have something by August 1, it will be a lousy summer.

Market News reviews the attitudes of the big bank analysts toward tomorrow’s statement, with several indicating the Fed may name bad conditions elsewhere in the world as a concern (Goldman, RBS), while expectations about employment are mixed. Some say underutilization will be the key word while others say the Fed will acknowledge labor market improvement. Both positions are plausible and consistent with Fed statements, which shows only that the Fed has us all buffaloed.

This is not how many angels can dance on the head of a pin—it’s “find the pin.” This lack of clarity is going to come back to haunt Yellen. We are all thoroughly fed up with Greenspanian obfuscation and won’t sit still for it again. Complaints will build and the Fed will be responsive—eventually. To be fair, Yellen is not Greenspan (thank goodness) but she isn’t Bernanke, either. By ending QE, a Bernanke pol-icy initiative, her term in office can begin on her terms.

To return to the divergence story: after the TICS report showed big inflows to the US (and big outflows by US investors in foreign equities), today we get a warning about outflows from Europe. Bloomberg reports fixed income outflows by domestic and foreign investors from the eurozone were €187.7 billion in the 6 months through August. This is the biggest outflow in all of ECB history. “While Draghi has acknowledged the need for a weaker euro to avoid deflation and make exports more competitive, strate-gists warn that outflows risk undermining the euro-region economy if they becomes too aggressive.” One analyst says “be careful what you wish for.”

And yet we mustn’t forget that experienced traders know the best time to buy is when there is blood in the streets. At the same time that they are now selling euros on rallies and playing a game when they buy on dips, at some point down the road the euro will be seriously undervalued and traders are already look-ing forward to it. So far forecasts of how far the euro will fall center around 1.2000-1.2500. It may seem a little strange to be thinking about the rally to come after the rout when the rout is currently in an up-ward correction, but that’s what we seem to be seeing. It’s a bit tangled but the real problem is trading hour to hour when the market is holding two opposing ideas in its head at the same time. The euro should fall on divergence favoring the dollar, but at some point the euro is always favored. Where are the tipping points for each move? We try to find them on the charts but sometimes events get in the way. Tomorrow’s Fed and next week’s ECB are the two events most likely to get in the way.